Statistical Methods

for Forecasting
10.1002/9780470316610.fmatter, Downloaded from https://onlinelibrary.wiley.com/doi/10.1002/9780470316610.fmatter by Papau New Guinea HINARI REGIONAL, Wiley Online Library on [23/04/2024]. See the Terms and Conditions (https://onlinelibrary.wiley.com/terms-and-conditions) on Wiley Online Library for rules of use; OA articles are governed by the applicable Creative Commons License
Statistical Methods

A JOHN WILEY & SONS, INC., PUBLICA'TION

for Forecasting

JOHANNES LEDOLTER

INTERSCIENCE
BOVAS ABRAHAM

WILEY-
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Copyright 0 1983.2005 by John Wiley & Sons, Inc. All rights reserved.
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ISBN-13 978-0-471-76987-3
ISBN- I0 0-47 I -76987-8

Printed in the United States of America.

I0987654321
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To our families
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Preface

Forecasting is an important part of decision malung, and many of our

decisions are based on predictions of future unknown events. Many books
on forecasting and time series analysis have been published recently. Somc
of them are introductory and just describe the various methods heuristically.
Certain others are very theoretical and focus on only a few selected topics.
This book is about the statistical methods and models that can be used to
produce short-term forecasts. Our objective is to provide an intermediate-
level discussion of a variety of statistical forecasting methods and models, to
explain their interconnections, and to bridge the gap between theory and
practice.
Forecast systems are introduced in Chapter 1. Various aspects of regres-
sion models are discussed in Chapter 2, and special problems that occur
when fitting regression models to time series data are considered. Chapters 3
and 4 apply the regression and smoothing approach to predict a single time
series. A brief introduction to seasonal adjustment methods is also given.
Parametric models for nonseasonal and seasonal time series are explained in
Chapters 5 and 6. Procedures for building such models and generating
forecasts are discussed. Chapter 7 describes the relationships between the
forecasts produced from exponential smoothing and those produced from
parametric time series models. Several advanced topics, such as transfer
function modeling, state space models, Kalman filtering, Bayesian forecast-
ing, and methods for forecast evaluation, comparison, and control are given
in Chapter 8. Exercises are provided in the back of the book for each
chapter .
This book evolved from lecture notes for an MBA forecasting course and
from notes for advanced undergraduate and beginning graduate statistics
courses we have taught at the University of Waterloo and at the University
of Iowa. It is oriented toward advanced undergraduate and beginning
graduate students in statistics, business, engineering, and the social sciences.
vii
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viii PREFACE

A calculus background, some familiarity with matrix algebra, and an

intermediate course in mathematical statistics are sufficient prerequisites.
Most business schools require their doctoral students to take courses in
regression, forecasting, and time series analysis, and most offer courses
in forecasting as an elective for MBA students. Courses in regression and in
applied time series at the advanced undergraduate and beginning graduate
level are also part of most statistics programs. This book can be used in
several ways. It can serve as a text for a two-semester sequence in regression,
forecasting, and time series analysis for Ph.D. business students, for MBA
students with an area of concentration in quantitative methods, and for
advanced undergraduate or beginning graduate students in applied statis-
tics. It can also be used as a text for a one-semester course in forecasting
(emphasis on Chapters 3 to 7), for a one-semester course in applied time
series analysis (Chapters 5 to 8), or for a one-semester course in regression
analysis (Chapter 2, and parts of Chapters 3 and 4). In addition, the book
should be useful for the professional forecast practitioner.
We are grateful to a number of friends who helped in the preparation of
this book. We are glad to record our thanks to Steve Brier, Bob Hog& Paul
Horn, and K. Vijayan, who commented on various parts of the manuscript.
Any errors and omissions in this book are, of course, ours. We appreciate
the patience and careful typing of the secretarial staff at the College of
Business Administration, University of Iowa and of Marion Kaufman and
Lynda Hohner at the Department of Statistics, University of Waterloo. We
are thankful for the many suggestions we received from our students in
forecasting, regression, and time series courses. We are also grateful to the
Biometrika trustees for permission to reprint condensed and adapted ver-
sions of Tables 8, 12 and 18 from Biometrika Tables for Statisticians, edited
by E . S. Pearson and H. 0. Hartley.
We are greatly indebted to George Box who taught us time series analysis
while we were graduate students at the University of Wisconsin. We wish to
thank him for his guidance and for the wisdom which he shared so freely. It
is also a pleasure to acknowledge George Tiao for his warm encouragement.
His enthusiasm and enlightenment has been a constant source of inspira-
tion.
We could not possibly discuss every issue in statistical forecasting.
However, we hope that this volume provides the background that will allow
the reader to adapt the methods included here to his or her particular needs.

B. ABRAHAM
J. LEDOLTER
Waterloo, Ontario
Iowa City, Iowa
June I983
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Contents

1 INTRODUCTION AND SUMMARY 1

1.1 Importance of Good Forecasts

1.2 Classification of Forecast Methods
1.3 Conceptual Framework of a Forecast System
1.4 Choice of a Particular Forecast Model
1.5 Forecast Criteria
1.6 Outline of the Book

2 THE REGRESSION MODEL AND ITS APPLICATION IN FORECASTING 8

2.1 The Regression Model 9

2.1.1 Linear and Nonlinear Models, 10
2.2 Prediction from Regression Models with Known
Coefficients 12
2.3 Least Squares Estimates of Unknown Coefficients 13
2.3.1 Some Examples, 13
2.3.2 Estimation in the General Linear
Regression Model, 16
2.4 Properties of Least Squares Estimators 20
2.5 Confidence Intervals and Hypothesis Testing 25
2.5.1 Confidence Intervals, 25
2.5.2 Hypothesis Tests for Individual Coefficients, 26
2.5.3 A Simultaneous Test for Regression Coefficients, 26
2.5.4 General Hypothesis Tests: The Extra Sum of
Squares Principle, 27
2.5.5 Partial and Sequential F Tests, 29
ix
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X CONTENTS

2.6 Prediction from Regression Models with

Estimated Coefficients 30
2.6.1 Examples, 31
2.7 Examples 33
2.8 Model Selection Techniques 41
2.9 Multicollinearity 45
2.10 Indicator Variables 49
2.11 General Principles of Statistical Model Building 52
2.1 1.1 Model Specification, 53
2.1 1.2 Model Estimation, 54
2.1 1.3 Diagnostic Checking, 54
2.1 1.4 Lack of Fit Tests, 56
2.1 1.5 Nonconstant Variance and Variance-Stabilizing
Transformations, 58
2.12 Serial Correlation among the Errors 60
2.12.1 Serial Correlation in a Time Series, 6 1
2.12.2 Detection of Serial Correlation among the Errors
in the Regression Model, 63
2.12.3 Regression Models with Correlated Errors, 66
2.13 Weighted Least Squares 74

Appendix 2 Summary of Distribution Theory Results 77

3 REGRESSION AND EXPONENTIAL SMOOTHING METHODS TO

FORECAST NONSEASONAL TIME SERIES 79

3.1 Forecasting a Single Time Series 79

3.2 Constant Mean Model 81
3.2.1 Updating Forecasts, 82
3.2.2 Checking the Adequacy of the Model, 83
3.3 Locally Constant Mean Model and Simple
Exponential Smoothing 85
3.3.1 Updating Forecasts, 86
3.3.2 Actual Implementation of Simple
Exponential Smoothing, 87
3.3.3 Additional Comments and Example, 89
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CONTENTS xi

3.4 Regression Models with Time as Independent Variable 95

3.4.1 Examples, 96
3.4.2 Forecasts, 98
3.4.3 Updating Parameter Estimates and Forecasts, 100
3.5 Discounted Least Squares and General
Exponential Smoothing 101
3.5.1 Updating Parameter Estimates and Forecasts, 102
3.6 Locally Constant Linear Trend Model and Double
Exponential Smoothing 104
3.6.1 Updating Coefficient Estimates, 107
3.6.2 Another Interpretation of Double
Exponential Smoothing, 107
3.6.3 Actual Implementation of Double
Exponential Smoothing, 108
3.6.4 Examples, 110
3.7 Locally Quadratic Trend Model and Triple
Exponential Smoothing 120
3.7.1 Implementation of Triple Exponential Smoothing, 123
3.7.2 Extension to the General Polynomial Model and
Higher Order Exponential Smoothing, 124
3.8 Prediction Intervals for Future Values 125
3.8.1 Prediction Intervals for Sums of Future
Observations, 127
3.8.2 Examples, 127
3.8.3 Estimation of the Variance, 129
3.8.4 An Alternative Variance Estimate, 132
3.9 Further Comments 133

4 REGRESSION AND EXPONENTIAL SMOOTHING METHODS TO

FORECAST SEASONAL TIME SERIES 135

4.1 Seasonal Series 135

4.2 Globally Constant Seasonal Models 139
4.2.1 Modeling the Seasonality with Seasonal
Indicators, 140
4.2.2 Modeling the Seasonality with Trigonometric
Functions, 149
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xii CONTENTS

4.3 Locally Constant Seasonal Models 155

4.3.1 Locally Constant Seasonal Models Using
Seasonal Indicators, 158
4.3.2 Locally Constant Seasonal Models Using
Trigonometric Functions, 164
4.4 Winters’ Seasonal Forecast Procedures 167
4.4.1 Winters’ Additive Seasonal Forecast Procedure, 167
4.4.2 Winters’ Multiplicative Seasonal
Forecast Procedure, 170
4.5 Seasonal Adjustment 173
4.5.1 Regression Approach, 174
4.5.2 Smoothing Approach, 174
4.5.3 Seasonal Adjustment Procedures, 179
Appendix 4 Computer Programs for Seasonal Exponential
Smoothing 182
EXPSIND. General Exponential Smoothing with
Seasonal Indicators, 182
EXPHARM. General Exponential Smoothing
with Trigonometric Forecast Functions, 185
WINTERS 1. Winters’ Additive Forecast
Procedure, 188
WINTERM. Winters’ Multiplicative Forecast
Procedure, 190

5 STOCHASTIC TIME SERIES MODELS 192

5.1 Stochastic Processes 192

5.1.1 Stationary Stochastic Processes, 194
5.2 Stochastic Difference Equation Models 197
5.2.1 Autoregressive Processes, 199
5.2.2 Partial Autocorrelations, 209
5.2.3 Moving Average Processes, 213
5.2.4 Autoregressive Moving Average
(ARMA) Processes, 2 19
5.3 Nonstationary Processes 225
5.3.1 Nonstationarity, Differencing, and
Transformations, 225
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CONTENTS xiii

5.3.2 Autoregressive Integrated Moving Average

(ARIMA) Models, 231
5.3.3 Regression and ARIMA Models, 237
5.4 Forecasting 238
5.4.1 Examples, 240
5.4.2 Prediction Limits, 246
5.4.3 Forecast Updating, 247
5.5 Model Specification 248
5.6 Model Estimation 250
5.6.1 Maximum Likelihood Estimates, 250
5.6.2 Unconditional Least Squares Estimates, 253
5.6.3 Conditional Least Squares Estimates, 257
5.6.4 Nonlinear Estimation, 258
5.7 Model Checking 26 1
5.7.1 An Improved Approximation of the
Standard Error, 262
5.7.2 Portmanteau Test, 263
5.8 Examples 26 3
5.8.1 Yield Data, 264
5.8.2 Growth Rates, 267
5.8.3 Demand for Repair Parts, 270
Appendix 5 Exact Likelihood Functions for Three
Special Models 273
I. Exact Likelihood Function for an ARMA(1,l)
Process, 273
11. Exact Likelihood Function for an AR(1) Process, 278
111. Exact Likelihood Function for an MA(1) Process, 279

6 SEASONAL AUTOREGRESSIVE INTEGRATED MOVING AVERAGE MODELS 28 1

6.1 Multiplicative Seasonal Models 283

6.2 Autocorrelation and Partial Autocorrelation Functions
of Multiplicative Seasonal Models 285
6.2.1 Autocorrelation Function, 286
6.2.2 Partial Autocorrelation Function, 291
6.3 Nonmultiplicative Models 29 I
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xiv CONTENTS

6.4 Model Building 293

6.4.1 Model Specification, 293
6.4.2 Model Estimation, 299
6.4.3 Diagnostic Checking, 299
6.5 Regression and Seasonal ARIMA Models 299
6.6 Forecasting 302
6.7 Examples 306
6.7.1 Electricity Usage, 306
6.7.2 Gas Usage, 308
6.7.3 Housing Starts, 310
6.7.4 Car Sales, 310
6.7.5 Demand for Repair Parts, 313
6.8 Seasonal Adjustment Using Seasonal ARIMA Models 317
6.8.1 X-11-ARIMA, 317
6.8.2 Signal Extraction or Model-Based Seasonal
Adjustment Methods, 3 18
Appendix 6 Autocorrelations of the Multiplicative
(0, d , 1)(1, D, 1112 Model 319

7 RELATIONSHIPS BETWEEN FORECASTS FROM GENERAL

EXPONENTIAL SMOOTHINO AND FORECASTS FROM ARIMA
TIME SERIES MODELS 322

7.1 Preliminaries 322

7.1.1 General Exponential Smoothing, 322
7.1.2 ARIMA Time Series Models, 323
7.2 Relationships and Equivalence Results 327
7.2.1 Illustrative Examples, 329
7.3 Interpretation of the Results 330
Appendix 7 Proof of the Equivalence Theorem 33 1

8 SPECIAL TOPICS 336

8.1 Transfer Function Analysis 336

8.1.1 Construction of Transfer Function-Noise
Models, 338
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CONTENTS xv

8.1.2 Forecasting, 344

8.1.3 Related Models, 348
8.1.4 Example, 348
8.2 Intervention Analysis and Outliers 355
8.2.1 Intervention Analysis, 355
8.2.2 Outliers, 356
8.3 The State Space Forecasting Approach, Kalman
Filtering, and Related Topics 359
8.3.1 Recursive Estimation and Kalman Filtering, 361
8.3.2 Bayesian Forecasting, 363
8.3.3 Models with Time-Varying Coefficients, 364
8.4 Adaptive Filtering 368
8.5 Forecast Evaluation, Comparison, and Control 370
8.5.1 Forecast Evaluation, 372
8.5.2 Forecast Comparison, 373
8.5.3 Forecast Control, 374
8.5.4 Adaptive Exponential Smoothing, 377

REFERENCES 379

EXERCISES 386

DATA APPENDIX 418

TABLE APPENDIX 426

AUTHOR INDEX 435

SUBJECT INDEX 437